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Top-down approach to investing

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Because the top-down approach begins at the top, the first step is to determine the state of the world economy. This is done by analyzing not only the developed countries but also emerging countries. A quick way to determine the state of an economy is to look at gross domestic product GDP growth over the past few years and the estimates going forward.

Often, the emerging market countries will have the best growth numbers when compared with their mature counterparts. Unfortunately, because we live at a time in which war and geopolitical tensions are heightened, we must be mindful of what is currently affecting each region of the world.

A few regions and countries throughout the world will fall off the radar immediately and will no longer be included in the remainder of the analysis due to the amount of financial instability that could wreak havoc on any investments. After determining which regions present a high reward-to-risk ratio, the next step is to use charts and technical analysis of macro trends. By looking at a long-term chart of the specific countries' economic indicators and broad stock market index, we can determine whether the corresponding stock market is in an uptrend and worth analyzing, or is in a downtrend, which would not be an appropriate place to put our money at this time.

These first two steps can help you discover the countries that would match your wants and needs for diversification. The third step is to do a more in-depth analysis of the U. By examining the economic numbers such as interest rates , inflation, and employment, we can determine the current market strength and have a better idea of what the future holds.

There is often a divergence between the story the economic numbers tell and the trend of the stock market indexes. The final steps in macroanalysis are to analyze the major U. Both fundamental and technical analysis can be used as barometers to determine the robustness of the indices.

The market's fundamentals can be determined by such ratios as price-to-earnings , price-to-sales, and dividend yields. Comparing the numbers to past readings can help determine whether the market level is historically overbought or oversold. Technical analysis will help ascertain where the market is in relation to the long-term cycle. Use charts showing the past several decades and zone down the time horizon to a daily view.

For example, indicators such as the day and day moving averages help us find the current market trend and whether it is appropriate for investors to be invested heavily in equities. So far, our process has taken a macro approach to the market and has helped us determine our asset allocation.

If, after the first few steps, we find that the results are bullish, there is a good chance a majority of the investment-worthy assets will be from the equities market. On the other hand, if the outlook is bleak, the allocation will shift its focus from equities to more conservative investments such as fixed income and money markets. Deciding on asset allocation is only half the battle. The next integral step will help investors determine which sectors to focus on when searching for specific investments such as stocks and exchange-traded funds ETFs.

Analyzing the pros and cons of specific sectors i. The process of analyzing the sectors involves tactics used in the prior approach, such as fundamental and technical analysis. In addition to the mentioned tools, investors must consider the long-term prospects of the specific sectors. For example, the emergence of an aging baby boomer generation over the next decade could serve as a major catalyst for sectors such as health care and leisure. Conversely, the increasing demand for energy coupled with higher prices is another long-term theme that could benefit the alternative energy and oil and gas sectors.

After the entire amount of information is processed, a number of sectors should rise to the top and offer investors the best opportunities. The emergence of ETFs and sector-specific mutual funds has allowed the top-down approach to end at this level in certain situations.

If an investor decides the biotech sector must be represented in the portfolio, they have the option of buying an ETF or mutual fund composed of a basket of biotech stocks. Instead of moving to the next step in the process and taking on the risk of an individual stock, the investor may choose to invest in the entire sector instead.

However, if an investor feels the added risk of selecting and buying an individual stock is worth the extra reward, there is an additional step in the process. This final phase of the top-down approach can often be the most intensive because it involves analyzing individual stocks from a number of perspectives.

An important aspect of individual stock analysis will be the company's growth potential over the next few years. Ideally, investors want to own a stock with a high growth potential because it will be more likely to lead to a high stock price.

Technical analysis will concentrate on the long-term weekly charts, as well as daily charts, for an entry price. At this point, the individual stocks are chosen, and the buying process begins. Proponents of the top-down approach argue the system can help investors determine an ideal asset allocation for a portfolio in any type of market environment. Often a top-down approach will uncover a situation that may not be appropriate for large investments into equities.

The ability to keep investors from over-investing in equities during a bear market is the biggest pro for the system. When a market is in a downtrend, the probability of picking winning investments drops dramatically even if the stock meets all the required conditions. When using the bottom-up system, an investor will determine which stocks to buy before considering the state of the market. This type of approach can lead to investors being overly exposed to equities, and the portfolio will likely suffer.

Other benefits to the top-down approach include diversification among not only top sectors, but also the leading foreign markets. This results in a portfolio that is diversified within the top investment-worthy sectors and regions. This type of investing is referred to in some small circles as "conversification," a mixture between concentration and diversification.

So far, the top-down approach may sound foolproof; however, investors must consider a few other factors. Personal Finance. Your Practice. Popular Courses. Investing Investing Essentials. What Is Top-Down Investing? Key Takeaways Top-down investing focuses on the macro factors of the economy, such as GDP, before examining micro factors such as specific sectors or companies. Top-down can be contrasted to bottom-up investing, which prioritizes the performance and fundamentals of individual companies before going to macro factors.

Top-down investing can help investors economize on the time and attention they have to bring to bear on their investments, but can also miss out on potentially profitable individual investments. Compare Accounts.

The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. Related Terms. Bottom-Up Investing Definition Bottom-up investing focuses on the analysis of individual stocks and de-emphasizes the significance of macroeconomic cycles. The Basics of Financial Analysis Financial analysis is the process of assessing specific entities to determine their suitability for investment.

Sector Analysis Sector analysis helps investors assess the economic and financial prospects of a sector of the economy to identify potentially profitable investments. Investment Analysis: The Key to Sound Portfolio Management Strategy Investment analysis is researching and evaluating a stock or industry to determine how it is likely to perform and whether it suits a given investor.

Value Investing: How to Invest Like Warren Buffett Value investors like Warren Buffett select undervalued stocks trading at less than their intrinsic book value that have long-term potential. What Is Fundamental Analysis? Fundamental analysis is a method of measuring a stock's intrinsic value.

Analysts who follow this method seek out companies priced below their real worth. Partner Links. Related Articles. Budgeting Top-Down vs. Bottom-Up: What's the Difference? Investopedia is part of the Dotdash Meredith publishing family.

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View forex quotes Technical Analysis Basic Education. Top-down top-down approach to investing may produce a more long-term strategic portfolio and favor passive indexing strategies, while a bottom-up approach may lead to more tactical, actively-managed strategies. By Justin Kuepper Full Bio LinkedIn Twitter Justin Kuepper is a financial analyst, journalist, and private investor with over 15 years of experience in the domestic and international markets. The final steps in macroanalysis are to analyze the major U. Most top-down investors focus on large trends through exchange-traded funds ETFs. Submit Unsubscribe Go to Subscribe. Top-down investing considers first macro-level economic or industry data before narrowing in on meso- and micro-factors to make investment decisions.
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Top-down approach to investing They'll take a deeper look at each one that comes up on the screener. Then you'll look at companies within these sectors before actually making an investment decision. By examining the economic numbers such as interest ratesinflation, and employment, we can determine the current market strength and have a better idea of what the future holds. Fisher Investments. If you invest broadly across all sectors of the economy in that country, you might top-down approach to investing lower returns, when you compare it to what would happen if you target those sectors that are growing the fastest, like retail, or which you predict will see the greatest growth in the near future.
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What Is Top-Down Investing? Top-down investing is an investment analysis approach that focuses on the macro factors of the economy, such as GDP, employment, taxation, interest rates, etc. before examining micro factors such as specific sectors or companies. Proponents of the top-down approach argue the system can help investors determine an ideal asset allocation for a portfolio in any type of market environment. However, we prefer a top-down investing approach. This method emphasizes broader economic factors. The strategy determines the allocation and selection of.